ABC Trucking\'s balance sheet shows a total of noncallable $31 million long-term
ID: 2801705 • Letter: A
Question
ABC Trucking's balance sheet shows a total of noncallable $31 million long-term debt with a coupon rate of 5.90% and a yield to maturity of 5.70%. This debt currently has a market value of $49 million. The balance sheet also shows that the company has 9 million shares of common stock, and the book value of the common equity is $189.20 million. The current stock price is $23.80 per share; stockholders' required return, rs, is 14.55%; and the firm's tax rate is 39.00%. The CFO thinks the WACC should be based on market value weights, but the president thinks book weights are more appropriate. What is the difference between the WACCs using market value and the book value? show work –0.51% –0.50% –0.57% –0.40% –0.62%
Explanation / Answer
WACC = Weight of debt x After tax cost of debt + Weight of equity x after tax cost of equity
WACC based on book value
total debt = 31000000
cost of debt = 5.7%
total equity = 189200000
cost of equity = 14.55%
Total value = 189200000 + 31000000 = 220200000
Weight of debt = 31000000/220200000 = 14.07%
Weight of equity = 1- weight of debt = 85.92%
WACC with book value = 85.92%*14.55%*(1-0.39) + 14.07%*5.70% = 0.07626+0.008025= 0.084284or 8.42%
WACC based on market value
Market value of debt = 49000000
Market value of equity = 23.8*9000000 = 214200000
Total market value of firm = 263200000
Weight of debt = 18.61%
Weight of equity = 1-18.61% = 81.39%
WACC with market value = 12.4885%
Difference in WACC = 12.4885%-8.4284% = 4.06%